Liquidity Provision During a Pandemic

CEPR Discussion Paper No. DP14701

Number of pages: 28Posted: 08 May 2020

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Date Written: May 2020

Abstract

We examine how public liquidity should be distributed to firms when immediate production entails externalities, such as by spreading a virus. Direct provision of liquidity can address externalities, but traditional distribution of liquidity (through banks) has informational advantages. We show that which mode is preferred is determined by the variance (but not the level) of firm characteristics in the economy. Traditional provision is always part of the optimal policy when liquidity modes can be combined, and involves promising low interest rates for when the pandemic is over in order to incentivize temporary production shutdowns at firms.

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